SELLING A BUSINESS

Many small business owners eventually decide to sell their companies,
though the reasons for such divestments vary widely from individual to
individual. Some owners may simply wish to retire, while others are
impatient to investigate new challenges—whether in business or some
other area—or tired of the frustrations of the business in which
they find themselves. Others decide to sell for reasons more closely
associated with the health of the business itself; disputes with partners,
incapacitation or death of principals, or downturns in the
company's financial performance can all spur business owners to
ponder putting their business on the block. Whatever their ultimate reason
for selling, though, business owners can get the most out of their company
by carefully considering a number of factors.

TIMING THE SALE OF A BUSINESS

"External economic forces, together with internal financial
performance, will dictate when you should put your company on the market
so as to achieve the maximum results," wrote Lawrence W. Tuller in
his book
Getting Out: A Step-by-Step Guide to Selling a Business or Professional
Practice.
"If the timing isn't right, it will take much longer to
sell the business, and the price you negotiate will inevitably be less
than you should get."

The financial performance and history of the company in question is often
the most important factor in determining price at the time of sale. A
business owner who chooses to sell after posting several years of steady
growth will naturally command a higher price than will the business owner
who decides to sell only a year or two into that growth trend, even if the
environment continues to appear friendly to the business for the
foreseeable future.

The business environment in which the company operates is also an
important factor in determining the asking price that the market will
bear. If the company in question operates in an industry that is suffering
through a downturn, the owner should delay selling the business if at all
possible. Few companies are able to buck the tide when the industry in
which they operate is stuck in a sluggish cycle, and even attractive
businesses will not shine as brightly during such periods. For most
business owners looking to sell their company, it is usually wise to ride
out the trough and put the company up for sale after the industry enters a
more robust cycle. Of course, some industries never post a recovery;
business owners engaged in under-performing industries need to determine
whether the downturns they experience are simply an inevitable part of the
business cycle within a basically healthy industry, or whether changes in
the marketplace are fundamentally altering the strength of the industry
(establishments as varied as roller rinks and hat manufacturers have been
relegated to the fringes of the American economy by the ever-changing
tastes of U.S. consumers).

The stock market is a third factor that should be analyzed when pondering
whether to put a company up for sale. "Stock market averages and
trends reflect not only the current health of the national economy, but
the projected conditions for the near future," pointed out Tuller.
"Major corporate decisions for capital appropriations, expansion or
contraction moves, and new product and service introductions are strongly
influenced by the perceived well being of the economy. In turn, the
magnitude of these corporate decisions affect investor confidence in the
stock market…. The price an entrepreneur can get for his company
will be heavily influenced by public investor attitudes."

STOCK SALES AND ASSET SALES

Another decision that some business owners need to make early in the
selling process is whether to hand over the company through a stock sale
or an asset sale. If a business has been incorporated, the owner has the
option of making a stock sale or an asset sale. Under the terms of a stock
sale, the seller receives an agreed-upon price for his or her shares in
the company, and after ownership of those stocks has been transferred, the
buyer steps in and operates the still-running business. Typically, such a
purchase means that the buyer receives not only all company assets, but
all company liabilities as well. This arrangement is often appealing to
the seller because of its tax advantages. The sale of stock qualifies as a
capital gain, and it enables the seller to avoid double taxation, since
sale proceeds flow directly to the seller without passing through the
corporation. In addition, a stock sale frees the seller from any future
legal action that might be leveled against the company. Lawsuits and
claims against the company become the sole responsibility of the new stock
owner(s).

Partnerships and sole proprietorships, meanwhile, must change hands via
asset sale arrangements, since stocks are not a part of the picture. Under
asset sale agreements, the seller hands over business equipment,
inventory, trademarks and patents, trade names, "goodwill,"
and other assets for an agreed-upon price. The seller then uses the money
to pay off any debts; the remainder is his or her profit. Changes in
ownership accomplished through asset transactions are generally favored by
buyers for two reasons. First, the transaction sometimes allows the buyer
to claim larger depreciation deductions on his or her taxes. Second, an
asset sale provides the buyer with greater protection from unknown or
undisclosed liabilities—such as lawsuits or problems with income
taxes or payroll withholding taxes—incurred by the previous owner.

PREPARING TO SELL

When preparing to sell a business, owners need to gather a wide variety of
information for potential buyers to review. Financial, legal, marketing,
and operations information all need to be prepared for examination.

FINANCIAL INFORMATION
Most privately held businesses are operated in ways that serve to
minimize the seller's tax liability. As John A. Johansen observed
in the SBA brochure
How to Buy or Sell a Business,
however, "the same operating techniques and accounting practices
that minimize tax liability also minimize the value of a business.
…It is possible to reconstruct financial statements to reflect the
actual operating performance of the business, [but] this process may also
put the owner in a position of having to pay back income taxes and
penalties. Therefore, plans to sell a business should be made years in
advance of the actual sale." Such a period of time allows the owner
to make the accounting changes that will put his or her business in the
best financial light. Certainly, a business venture that can point to
several years of optimum fiscal success is apt to receive more inquiries
than a business whose accounting practices—while quite sensible in
terms of creating a favorable tax environment for the owner—blunt
those bottom line financial numbers.

Would-be business sellers also need to prepare financial statements and
other documents for potential buyers to review. These include a complete
balance sheet (with detailed information on accounts receivable and
payable, inventory, real estate, machinery and
other equipment, liabilities, marketable securities, and schedules of
notes payable and mortgages payable), an income statement, and a valuation
report. The latter is an appraisal of the business's market value.

LEGAL INFORMATION
The seller should also prepare the necessary information on legal issues
pertaining to the company. These range from such basic operating documents
as articles of incorporation, bylaws, partnership agreements, supplier
agreements, and franchise agreements to data on regulatory requirements
(and whether they are being adhered to), current or pending legal actions
against the company, zoning requirements, lease terms, and stock status.

MARKETING INFORMATION
Intelligent buyers will want detailed marketing information on the
company as well, including data on the business's chief market
area, its market share, and marketing expenditures (on advertising,
consultants, etc.). In addition, product line information will also be
expected. Buyers, for instance, will want to know whether any of the
company's products are proprietary, or whether there are
potentially valuable new goods in the production pipeline. Descriptions of
pricing strategies, customer demographics, and competition should also be
available for potential buyers to review.

OPERATIONS INFORMATION
Finally, business owners looking to sell their company should be prepared
to provide detailed information on various aspects of the
business's day-to-day operations. The "operations"
umbrella encompasses everything from company policies to historical hours
of operation to personnel listings, including organizational charts (if
applicable), job descriptions, rates of pay, and benefits. Other factors
that can potentially impact one or more aspects of the company's
operations, such as the presence or absence of an employee union, will
also have to be detailed.

Once information on all facets of the business has been gathered, it
should be organized into a comprehensive business presentation package. A
complete business presentation package, remarked Johansen, should include
the following:

History of the business

Description of business operations

Description of physical facilities

Discussion of suppliers (if any) and agreements with those suppliers

Review of current and historical marketing practices

Description of competition

Coverage of personnel and employee issues

Identification of owners

Description of insurance coverage for business

Discussion of pending legal issues or contingent liabilities

Financial statements for the past three to five years

LOCATING PROSPECTIVE BUYERS

Most business owners sell their companies to external buyers—buyers
who are not current partners or employees in the organization. There are
three primary routes that sellers can take to notify these buyers of the
availability of their companies: print advertising, industry sources, and
intermediaries.

Many people hoping to sell their businesses make arrangements for
advertisements in the Thursday edition of the
Wall Street Journal,
which produces several regional versions of its paper around the country.
The
Journal
is a particularly popular option for owners of large, privately held
businesses. Owners of smaller businesses, meanwhile, often turn to the
classified sections of their own local newspapers to advertise the
availability of their company for acquisition. When submitting a
"business opportunity" advertisement for publication in the
newspaper, however, sellers need to take a sensible approach.
"There is a delicate balance to be struck in any kind of
advertising between the need for confidentiality and giving enough
information to attract potential buyers," wrote Michael K. Semanik
and John H. Wade in
The Complete Guide to Selling a Business.
"When your ads describe too much, competitors and others can
deduce who you are and find out information you don't want them to
know. Give too little information and you won't attract any
interest." Advertisements should provide a brief description of the
type of business for sale, its primary assets (location, popularity,
profitability, etc.), and a way for interested buyers to make contact.
Sellers who wish to maintain some degree of anonymity while looking for a
buyer may wish to arrange for a post office box rather than include their
telephone number.

Industry sources also can be valuable when a business owner decides to
sell his or her business. Suppliers, for instance, may know of potential
buyers lurking elsewhere in the industry or community. In addition, trade
associations and trade journals can be used to get the word out about a
company's availability.

A third option that many sellers use is to secure the services of a
business broker or merger and acquisition consultant to sell their
business. Business brokers, who generally handle the sale of smaller
companies (though this is by no means an absolute rule), typically charge
the seller a fee of about 10% of the
final purchase price. "Business brokers are exactly what the name
implies," wrote Tuller, "firms that list businesses for
sale, then advertise them for sale to the public. They are very similar to
real estate brokers but not licensed…. A business broker will not
usually investigate the businesses he lists but will rely entirely on data
given to him by you, the Seller. Valuation of the business is usually left
completely up to you, and although a reputable broker will make
suggestions, he is generally either not qualified or not interested in
spending much time analyzing the business to determine
marketability." Merger and acquisition consultants, on the other
hand, typically specialize in handling larger middle-market companies.
"Their coverage of the entrepreneurial market is usually very broad
and they generally know, within specialized industries or regions, which
larger companies are actively searching for additions to their product
lines or industry groupings," said Tuller. Payments to
"M&A" consultants are usually less than 10%, but this
is in part because of the larger scale of the deals in which they are
typically involved. In addition, many consultants ask for a monthly
retainer fee. One of the benefits of securing the services of a merger and
acquisition consultant is that he or she will typically provide help in
preparing presentation packages, valuing businesses, and negotiating with
prospective buyers.

A well chosen business broker or merger and acquisition consultant can
save the seller of a business a considerable amount of time and effort.
However, both groups include hucksters who prey on unwary business owners,
so it is important for sellers to conduct the appropriate background
research before soliciting services in these areas.

Another option sometimes available to business owners is to sell their
company to "internal" buyers—employees, business
partners, or family members. Selling to employees through employee stock
ownership plans (ESOPs) or other arrangements are particularly attractive
for business owners because they accrue significant tax advantages through
such sales. Employees interested in assuming ownership of the company via
a management buyout (MBO) could range from a single key employee, such as
a general manager who already has a good grasp on many aspects of the
enterprise, to a group of employees (or even all of the company's
employees). "This is fertile territory," claimed Tuller.
"Most employees yearn to have their own business. All employees are
concerned about someone else buying the company and either being fired, or
not being able to work for the new boss." Employee convictions that
they could improve on the owner's performance often play a part as
well. Finally, noted Tuller, "when it comes time to finance the
sale, bankers will bend over backwards to assist a [management buyout],
although they might not be interested at all in an outside buyer."
MBOs that rely on external financing, however, typically require that one
or members of the purchasing group have management training in all aspects
of the business; if such expertise is lacking, the seller will need to
implement a training schedule for one or more employees to fulfill this
requirement.

Business partners, meanwhile, are often ideal business buyers when an
owner is ready to get out. Indeed, many business owners—especially
in professional practices—bring in partners for this express
purpose. The advantages of selling to a partner are numerous: the need to
search for a buyer—or to use an intermediary—is obviated;
terms of payment are often easier to arrange; and the business transition
is eased because of the familiarity that already exists between the
partner and the enterprise's suppliers, clients, and customers.
Small business owners looking to hand over the reins of a company to a
partner, however, need to adequately prepare for such a step. Locating a
suitable partner, structuring a partnership buyout, and financing a
partnership buyout are all important and complex issues that require care
and attention.

Finally, business owners also groom people within their organization to
take over the business upon their retirement (or death or disability).
Family-owned businesses often hand over the reins from generation to
generation in this fashion. In many cases this transfer of ownership is
made as a gift or included as part of the owner's estate.

MAKING THE SALE

Once the seller has found a buyer for his or her company, the next step is
to arrange the structure of the transaction. In addition to determining
whether to make a stock or asset sale (in the case of corporations), the
seller and the buyer need to reach agreement on other terms of the sale as
well.

EARN-OUTS
An earn out is an agreement wherein the seller takes a portion of the
selling price each year for a fixed period of time out of the earnings of
the company under its new ownership. These agreements are sometimes
employed when a seller cannot get his or her full asking price because of
buyer concerns about some aspect of the business. "Most earn out
plans are contingent on the level of profits a company earns,"
wrote Tuller. "No profits, no payments." As a result, some
sellers insist on minimum payment amounts. In addition, since the
seller's total compensation under this arrangement depends on the
company's performance during the specified earn-out period, sellers
often require that they be involved in management decisions during this
period. Earn-outs can be calculated as a percentage of gross profit, net
profit, sales, or some other mutually agreed-upon figure.
Sellers, however, need to make sure that the measurement used is fair and
easily verifiable. As Semanik and Wade noted, "profit is a very
difficult word to define. A shrewd purchaser could allocate costs in such
a way that profit expectations are repeatedly dashed."

INSTALLMENT SALES
Under this common arrangement, the seller of the business receives some
cash, but the majority of the purchase price is received over a period of
years. The down payment for small businesses may range from as little as
10 percent to as much as 40 percent or more, with the rest paid
out—with interest—over a period of 3-15 years.

LEVERAGED BUYOUT
A leveraged buyout or LBO is the purchase of a company through a loan
secured by using the assets of the business as collateral. This option,
however, places a greater debt burden on the company than do other types
of financing.

STOCK EXCHANGES
In instances where a large, publicly held company is the purchaser,
business owners sometimes ask to be compensated with stock in the
purchasing corporation. In such cases, the seller is usually required to
hold on to the stock for a certain period of time—usually two
years—before he or she has the option to resell it.

Buyers sometimes insist on a noncompetition clause as well. "The
noncompete agreement is a fair clause in any sales contract," wrote
Semanik and Wade, "because it prevents a seller from opening across
the street (or town) and winning back the customers." This covenant
not to compete with the buyer, which can be incorporated into the purchase
and sale agreement or created as a separate document, usually stipulates a
market area and/or a period of time (three to five years is common) in
which the seller may not open a business that would compete with the
enterprise that he or she previously sold.

CLOSING THE DEAL

Once a deal has been struck between the seller and the buyer of the
business, various conditions of sale often have to be addressed before the
deal is closed. These include verification of financial statements,
transfer of licenses, obtaining financing, and other conditions. Most
contracts call for these conditions of sale to be addressed by a specified
date; if one or more of these conditions is not taken care of by that
time, the agreement is no longer valid.

Provided that these conditions have been attended to, however, the parties
can move on to the closing. Closings are generally done either via an
escrow settlement or via an attorney performs settlement. In an escrow
settlement, the money to be deposited, the bill of sale, and other
relevant documents are placed with a neutral third party known as an
escrow agent until all conditions of sale have been met. The escrow agent
then distributes the held documents and funds in accordance with the terms
of the contract.

In an attorney performs settlement, meanwhile, an attorney—acting
on behalf of both buyer or seller, or for the buyer—draws up a
contract and acts as an escrow agent until all stipulated conditions of
sale have been met. Whereas escrow settlements do not require the buyer
and the seller to get together to sign the final documents,
attorney-performed settlements do include this step.

Several documents are required to complete the transaction between
business seller and business buyer. The purchase and sale agreement is the
most important of these, but other documents often used in closings
include the escrow agreement; bill of sale; promissory note; security
agreement; settlement sheet; financing statement; and employment
agreement.

FURTHER READING:

Currie, Phillip L. "When Time is Right, Consider Selling the
Business."
San Diego Business Journal.
October 2, 2000.

Johansen, John A.
How to Buy or Sell a Business.
Small Business Administration, n.a.

"Selling Your Business: How to Structure and Negotiate the Best
Deal."
The Business Owner.
January-February 2001.

Semanik, Michael K., and John H. Wade.
The Complete Guide to Selling a Business.
AMACOM, 1994.

Tuller, Lawrence W.
Getting Out: A Step-by-Step Guide to Selling a Business or Professional
Practice.
Liberty Hall Press, 1990.